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Proposed regulations address Section 45X tax credit
December 2023
In brief
What happened?
The IRS and Treasury on December 15 published proposed regulations under Section 45X, the advanced manufacturing production credit. The proposed regulations provide definitions and rules relating to eligible components, qualified and nonqualified production activities (including production under a contract manufacturing arrangement), costs included and excluded as production costs, sales to related persons, and interaction with the Section 48C(e) investment tax credit. The regulations are proposed to apply to eligible components produced and sold after 2022 in tax years ending on or after final regulations are published in the Federal Register.
Why is it relevant?
Section 45X proposed regulations have been needed to provide guidance on a number of difficult issues. The proposed regulations provide some clarity on issues such as whether a taxpayer’s manufacturing activities may qualify for both the Section 48C(e) investment tax credit and the Section 45X production credit (and which credit would be more beneficial) but leave several open questions.
What to consider:
Each section of the regulations includes a severability clause providing that the invalidation of any provision of that section does not invalidate any other rules in that section. This provision may illustrate the difficulty of resolving some of the pending issues and the expectation that some proposed approaches may be controversial. Taxpayers may want to consider providing comments, which are due by February 13, 2024. A public hearing is scheduled for February 22, 2024.
In detail
Statutory background
Effective beginning in 2023, Section 45X provides a tax credit for (1) eligible components, (2) produced by a taxpayer, (3) in the United States or a US possession, (4) in the course of a trade or business, and (5) sold by the taxpayer to unrelated persons during the tax year.
Eligible components
Eligible components include solar energy components (solar modules, photovoltaic cells, photovoltaic wafers, solar grade polysilicon, torque tubes or structural fasteners, and polymeric backsheets), wind energy components (blades, nacelles, towers, offshore wind foundations, and related offshore vessels), inverters (an end product that converts direct current electricity from solar modules or wind energy systems into alternating current electricity), and qualifying battery components (electrode active materials, battery cells, and battery modules). Section 45X defines each of these components.
Eligible components do not include components produced at a facility that includes any property for which the basis was taken into account after August 16, 2022, for the Section 48C investment tax credit.
Eligible components also include applicable critical minerals. In accordance with the Energy Act of 2020, the Department of the Interior (DOI) publishes periodic guidance, most recently for 2022, identifying “critical minerals.” Section 45X specifically designates the 50 substances identified in the 2022 DOI guidance as “applicable critical minerals.”
Observation: The Energy Act of 2020 also requires the Department of Energy (DOE) to identify ”critical materials.“ The DOE list includes the 50 critical minerals and additional substances that are determined to be essential to an energy technology and to have a high risk of supply chain disruption. This expanded list is not relevant to the definition of applicable critical minerals under Section 45X.
Section 45X specifies purity requirements for each applicable critical mineral, including minerals converted to or from another substance. For example, aluminum is an applicable critical mineral if it is either (1) converted from bauxite to a minimum purity of 99% alumina by mass or (2) purified to a minimum purity of 99.9% aluminum by mass; lithium is an applicable critical mineral if it is either (1) converted to lithium carbonate or lithium hydroxide or (2) purified to a minimum of 99.9% lithium by mass.
Related persons
Related persons for purposes of Section 45X are trades or businesses that would be treated as a single employer under Section 52(b), i.e., are under common control. However, a taxpayer is treated as selling a component to an unrelated person if (1) the related person sells the component to an unrelated person or (2) the component is integrated, incorporated, or assembled into another eligible component sold to an unrelated person. A taxpayer also may elect to treat a sale to a related person as made to an unrelated person, subject to Treasury registration and information reporting requirements.
Credit amount
The Section 45X credit amount varies depending on the type of component. For example, the credit is 4 cents times the direct current watt capacity of a photovoltaic cell, $12 per square meter of a photovoltaic wafer, 87 cents per kilogram of torque tubes, 10% of the sales price of an offshore wind vessel, and $35 times the kilowatt/hour capacity of a battery cell. The credit amount for electrode active materials and applicable critical minerals is 10% of production costs. No credit bonuses are available.
The Section 45X credit is phased out as follows: for components sold in calendar year 2030, the credit is 75% of the otherwise allowable amount; in 2031, 50%; in 2032, 25%; and after 2032, zero. The phaseout does not apply to applicable critical minerals.
Proposed regulations
Production activities
The proposed regulations specify that, to be eligible for the Section 45X credit, a taxpayer must directly perform the production activities that create the eligible component and must be the seller of the component to an unrelated person. The taxpayer may perform the production under a contract manufacturing arrangement, defined as an agreement entered into before production of the component is completed. The parties to a contract manufacturing arrangement may determine which party may claim the Section 45X credit. The IRS will not challenge the determination if all parties submit signed certification statements providing certain information.
Observation: The IRS and Treasury considered a similar rule allowing parties to a contract to determine eligibility to claim a domestic manufacturing deduction under former Section 199, but did not adopt it. Examples in the proposed regulations illustrate that, if a contract manufacturer is considered under general tax principles to be performing a service for, and not selling property to, the principal, and the principal uses rather than sells the eligible component, neither party would be eligible for the Section 45X credit. Contracts to produce eligible components should be carefully drafted to avoid this issue.
The proposed regulations define “produced by the taxpayer” as a process conducted by the taxpayer that substantially transforms constituent elements, materials, or subcomponents (inputs) into a complete and distinct eligible component. For solar grade polysilicon, electrode active materials, and applicable critical minerals, production is processing, converting, refining, or purifying source materials (such as brines, ores, or waste streams) to create a distinct eligible component. The proposed regulations define “conversion” as a chemical transformation from one species to another and “purification” as increasing the mass fraction of an element.
Observation: The separate definitions of production may result in treating taxpayers differently depending on their activities. For example, the regulations may be interpreted to allow a taxpayer that substantially transforms inputs into an electrode active material, substantially transforms the material into a battery cell, and then substantially transforms the cell into a battery module, to claim a Section 45X credit for three eligible components. However, a taxpayer that both purifies applicable critical minerals and uses them to produce electrode active materials may be able to claim a Section 45X credit for only one component, and allocating costs between each production activity may be challenging. If different taxpayers produce the applicable critical minerals and electrode active materials, each may be able to claim a Section 45X credit. The related party election may help to level the playing field for vertically integrated taxpayers, but a taxpayer that performs both these activities may be limited to one credit.
Partial transformation, mere assembly, or superficial modification of inputs do not qualify as production.
Observation: A taxpayer that completes the production process for an eligible component that another taxpayer has partially transformed may be considered to be engaged in minor assembly or superficial modification. In that case, neither taxpayer may be eligible to claim a Section 45X credit for that component. Multiple parties participating in the production process of eligible components may want to consider forming a joint venture or other partnering arrangement to avoid this problem.
The proposed regulations specify that production of an eligible component may have begun before 2023 but must be completed, and sale must occur, after 2022.
Eligible components
In general
The proposed regulations expand on and clarify the statutory definitions for some eligible components. For example, the proposed regulations provide that the capacity of a photovoltaic cell or a solar module is nameplate capacity in direct current watts using standard test conditions as defined by the International Electrochemical Commission (IEC). The proposed regulations specify documentation requirements for some components, for example a bill of sale or IEC certification for a photovoltaic cell or solar module and a specification sheet or bill of sale for a torque tube. A taxpayer must provide the purchaser of an applicable critical mineral with a certificate of analysis documenting that the mineral meets the statutory requirements.
Interaction with Section 48C
The proposed regulations provide that an eligible component must be produced in a “Section 45X facility” and does not include any property produced by a “production unit” that is eligible property for, and was included in a facility that received, a Section 48C credit. A Section 45X facility includes all tangible property that comprises an independently functioning production unit that produces one or more eligible components. A production unit is the tangible property that substantially transforms the material inputs to complete the production process
Observation: The proposed regulations provide examples involving a single production unit located at more than one Section 45X facility and multiple production units located at a single facility. The examples indicate that the Section 45X ineligibility of a production unit at a facility for which a taxpayer received a Section 48C credit does not affect the Section 45X eligibility of other, co-located production units that are not eligible property for Section 48C. The examples rely heavily on serial positioning rather than parallel positioning of the units to make this determination.
Production costs
The proposed regulations provide that production costs (the basis of the credit for electrode active materials and applicable critical minerals) include all costs described in Reg. 1.263A-1(e), except direct or indirect costs for materials and costs related to extracting raw materials.
Observation: The preamble to the proposed regulations identifies labor, electricity, storage, depreciation or amortization, recycling, and overhead as some costs included in production costs. Excluded material costs include the cost of materials used for converting, purifying, or recycling raw material and other material costs related to producing an applicable critical mineral. The omission of materials from the definition of costs is a significant departure from the rules defining production costs under Section 263A.
Sales to related persons
In general
The proposed regulations provide that whether a disposition of a component is a sale is determined under federal income tax principles. A “person” related to the taxpayer may be an individual, trust, estate, partnership, association, company, or corporation, but not a disregarded entity.
Observation: Although the proposed regulations define “person” broadly, a person is related under the Section 45X statutory definition only if it is a trade or business.
In an example, the proposed regulations specify that a taxpayer that sells an eligible component to a related person, that in turn sells the component to an unrelated person, may claim the Section 45X credit only in the tax year of the sale to the unrelated person.
Related person election
The proposed regulations provide that a taxpayer makes the election to treat a related person as unrelated annually on the taxpayer’s timely filed (including extensions) original federal income tax return. The taxpayer must include information to be specified in guidance. The election is made for a specific trade or business of the taxpayer and applies to all sales of eligible components to related persons during a tax year by that trade or business.
The election applies separately to each member of a consolidated group that claims the Section 45X credit and is made by the agent for the group on the group’s tax return. A partnership makes the election on the partnership’s tax return for each trade or business that the partnership conducts.
A related person election is invalid if the taxpayer fails to provide required information to the IRS, the related person does not put a component to productive use, or the component does not meet the Section 45X requirements
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